EBay's margins likely to stay squeezed

Bear Stearns downgrades Internet auctioneer

MarkCotton

NEW YORK (MarketWatch) -- Shares of eBay Inc. dipped Monday after Bear Stearns downgraded the Internet auctioneer, citing little likelihood for any rebound in the company's profit margins in 2006.

Ebay's stock closed down 0.4% at $36.94, having earlier touched a low of $36.39.

Analyst Robert Peck lowered his rating on eBay
EBAY, +1.99%
to peer perform from outperform, characterizing 2006 as a "year of investment" for the company as it fends off intensifying competition in China.

The analyst cut his 2005 price target by $8 to $37. And for 2006, he established a $40 price target

"After returning from our trip to China, we think that eBay will need to continue to invest in 2006, potentially pushing off any rebound in near-term margins," said Peck.

Although Peck said eBay's established an early lead in the Chinese market via the purchase of EachNet for around $180 million in June 2003, he's concerned that a decision by the company to charge for listings on its site may have left the door open to increased competition from rival auction site TaoBao, which will continue to offer free listings until at least June 2006.

TaoBao is also likely to benefit from a decision by Yahoo Inc.
YHOO, +0.80%
to invest in Alibaba, its Chinese parent company.

Adding to the analyst's concern is eBay's new policy of not giving out information on how its Chinese business is performing in contrast to its competitor, which continues to offer updated industry metrics.

"As long as eBay continues its current policy on non-disclosure of these metrics, we think investors will be very cautious as to their expectations of eBay's success in China, which would weigh on the stock," Peck said.

Digesting recent acquisitions

In addition, the integration of recent acquisitions, notably Shopping.com and Skype Technologies, will occupy a lot of management's time in 2006.

Although Peck thinks these acquisitions will be beneficial for the company in the long term, integrating "two large businesses with very different business models than eBay's core model is no small task" and will divert attention away from its core operations.

He's also concerned that integration costs remain somewhat "ambiguous" and are unlikely to be fully realized until the integration process begins."

The acquisition of Skype, which offers telephone services over the Internet, offers both benefits and dangers for eBay, according to Peck.

Communicating by phone over the Internet could make it easier for eBay buyers and sellers to complete their transactions, particularly on larger-ticket items.

"However, this is also a potential negative as well, as buyers and sellers communicating on 'the phone' makes it easier to take transactions off eBay," said Peck.

Regarding the purchase of Shopping.com, one of the issues facing eBay is how to integrate listings from one platform to another without suppressing average selling prices and conversion rates.

"We have been told that [average selling prices] on Shopping.com can be up to 25% higher than eBay, which makes integration of similar items more difficult," said the analyst.

The Shopping.com site offers price comparisons for a whole range of consumer products, including clothing, computers, electronics and jewelry items.

Other areas of concern

Among other areas concern, Peck warns of possible increased competition from Google Inc.
GOOG, +1.37%
especially in the area of fixed listings, which make up around 30% of eBay's total listings. Fixed-price listings allows users to buy and sell items at a set price, with no bidding or waiting.

The analyst said Google could facilitate this type of commerce directly from its search bar. A user could, say, search for "red children's bike," and Google could offer up local listings near the user selling the item.

There's also the threat of rising competition from local listings. Peck said eBay has acknowledged the popularity of such sites with the establishment of Kijiji.com, where users can place job advertisements as well as personal and classified ads on a site geared specifically to the country, and often the town or city, in which they live.

Kijiji's site closely mirrors the services offered by Craigslist.org, an online community site in which eBay already has a stake. Peck said these sites could continue to siphon away a small portion of eBay's gross merchandise volume.

EBay may find it difficult to raise listing fees in 2006 as other sites look to steal some of its business, raising the competition for customers.

"Yahoo! has launched free listings in the U.S. and Overstock
OSTK, +0.29%
continues to aim stealing some traffic from eBay as well," said the analyst. "Of particular interest will be when/if eBay will gain pricing power in China."

The development of "meta-auctions" could also prove a potential threat to eBay's business model, according to the analyst. Such auctions would allow a customer to find an item by combing through all major Internet auction sites. The customer would then bid for the item on the auction site that offers it at the cheapest price.

"Auctionshark.com has recently begun a trial of meta-auctions," said Peck. "Should these types of services gain momentum, they could increase the competition to eBay (or at least potentially increase marketing costs.)"

Disclosing its interest in eBay, Bear Stearns said the online auctioneer is or has been a non-investment banking client in the past 12 months.

The investment bank is also a market maker in the company's equity securities.

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